Friday, February 14, 2014

As a company CFO, I routinely speak with our staff -- most of whom are in their 20s and 30s -- about the need to plan for their retirements and to get started with an aggressive savings plan NOW. I gave such a talk today, Valentine's Day, 2014. In keeping with the theme of love and commitment, I came up with the idea of treating your 401(k) like a life partner; i.e., whatever you make, think about sharing it 50/50 with your partner. Obviously, you can't share your entire salary with your 401(k). However, annual raises can be thought somewhat as being "found money," and if quickly shared on a 50/50 basis with the 401(k), the employee will simply moderate their lifestyle based on their remaining take-home pay, and they'll never miss what gets tucked away in the 401(k). Here's a scenario:

Pat and Chris start their careers at the same time and at the same salary.

They both get $5,000 raises following each of their first 5 years of work, followed by 4% annual raises thereafter.

They both start their 401(k) contributions at 10% of their gross pay.

Pat maintains his contributions throughout his career at 10% of his pay.

Chris "marries" her 401(k) and splits all of her raises 50/50 with her 401(k) plan; i.e., whatever her raise, half of
it goes to her 401(k).

Chris hits the current annual contribution max of $17,500 in Year 6. She continues to contribute the max thereafter. [Take note: after 5 years of employment, both Chris and Pat have increased their salaries by $25,000. Stingy Pat has only given an extra $2,500 to his 401(k). Generous and loving Chris has shared her increase 50/50 to the tune of $12,500 with her 401(k).]

We'll keep things simple and won't show Chris or Pat taking advantage of the additional catch-up contribution of $5,500/year when they reach 50.

We'll assume the IRS authorizes 3% annual increases in the max during that time.

We'll also assume a 7% investment return and a 40-year career.

After 40 years of work, Chris ends up with roughly $4.3 million in her 401(k), almost double Pat's total. If she draws on that money at a rate of 4% of the ending investment balance, she'll be able to replace 61% of her ending pre-retirement salary, whereas Pat will only be able to replace 31% of his. Adding social security on top of Chris's draw, she'll probably be pretty comfortable in retirement. Pat, on the other hand, needs a part-time job in retirement.

Is this a gimmick? Maybe, but I'd rather think of it as being a rational method to enforce a savings discipline. Retirement doesn't fund itself, and few people have pensions any longer. So, if it takes a gimmick to help people reach financial security, I'm all for it.
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About Me

Pat has nearly 30 years of experience as a financial executive. He is a CPA and holds an MBA from MIT's Sloan School of Management, where he was a Sloan Fellow. Pat's research interests include investments, financial markets, leadership and ethics, innovation and business sustainability, I.T. strategy, corporate governance, economics, politics, and globalization.